Budget Gem 3: Move towards continuous budgeting

October 1, 2013

Why Annual Budgeting?

Have you ever wondered why organisations set an annual budget? Yes it fits in nicely with the way an organisation views performance; the way in which employees are reviewed for the work they do; and it's easy to schedule. It's September so it must be time to budget.
But there are also some major downsides:

It requires managers to guess performance 15 months out when in reality, forecasting the next 6 months is a real challenge.

Competitor actions and changes in customer attitudes are rarely aligned with the frequency and timescales of the budget process

Running with a budget that is out of date, and that doesn't allow an organisation to respond to change simply doesn't make sense.

The trouble is that most organisations spend around 4 months generating a budget and so doing this several times a year is not an option. What it requires is a rethink on what is budgeted and how the budget process is conducted.

There's not enough space here to cover how to do this in detail, but basically one good method is to split budgets into two parts: 'Business as Usual' and 'Strategic initiatives'.
With 'business as usual', budgeting becomes a rolling forecast process. In other words, the resources required to run a department are generally known from one month to the next as they are closely linked to everyday actions and the outcomes they are expected to generate. For example, the role of the finance department is to produce invoices, collect cash and pay expenses. (For those of you in Finance reading this, please forgive the gross simplification!). To do this requires a certain number of staff, office space, paper and computer systems. The cost of these are pretty much well known and can be predicted many years in advance, provided nothing changes. All we need to know is the cost of doing this today and an estimate of how these are affected by inflation over time.
This exercise can be conducted for most business / departmental functions as can overheads and other regular payments. The generation of the budget can then be automated and periodically reviewed to ensure that the each departments budget represents value for money.
Strategic Initiatives on the other hand are those activities that are not being done at present, whose purpose is to improve the existing 'business as usual' activities. These can be considered as projects that have defined timescales, an estimate of the resources required and measures that show how they improve business process outcomes.
Strategic initiatives can be planned at any time. This could be in response to competitor actions; an unplanned change to the business environment; or simply the need to improve the performance of a particular department. As initiatives are proposed they can be assessed in combinations along with the 'business as usual' resources to work out which ones should be implemented.
By doing this, budgeting can become a continuous process that is able to respond to unpredictable events. It is still able to provide an 'annual view' simply by looking at the next 12 months, but it eradicates much of the game playing and time lost through guessing numbers that no one really believes.